Routinely, I have clients come to me to ‘document’ transactions for them, meaning I am responsible for putting together the various contracts and agreements that will serve to create the legal obligations between the parties to the transaction. Despite having documented more deals than I can count, representing likely close to 100 million dollars changing hands, if not more, I still have to stay ‘dialed in’ when completing due diligence for each and every transaction. Due diligence is a blanket term I use to describe the research and review that should be done to verify that the ‘deal’ really is what you believe it is. If you fail to do your due diligence, you run the risk of losing what you’ve worked so hard to achieve.
Most recently, I had a client come to me to assist in preparing the documents for a transaction where my client was to serve as the lender in a transaction where their borrower was buying an investment property. In this article, I’ll briefly take you through the various items I reviewed in conducting my due diligence for my client, and I’ll try to shed light on why, in this scenario, due diligence was so important.
First, I did a summary review of the ALTA title policy that had been issued to cover the transaction. The title policy protects both the buyer (my client’s borrower) as well as the lender (my client) from potential issues that may exist with title on the property. In reviewing the title policy, I paid the most attention to the section entitled ‘exceptions’, as that is the list of encumbrances to title that exist that the title company has identified in their title research, and which the title company is not covering. If there is an exception listed, and you don’t want to take title subject to that exception, you need to work with the seller to make sure that such exception is resolved before the transaction closes. As my client is the lender, I was reviewing the title policy for exceptions that would limit my client’s ability to recover the amounts it lends in the instance that the borrower fails to pay. In this transaction, there were no significant encumbrances that raised red flags, so I moved on with my review.
Second, I reviewed the financials and disclosed information regarding the property itself, the borrower, and the personal guarantors (those parties who were making themselves individually liable for the debt if the borrower failed to meet its contractual obligations). For you, I would call this your ‘financial’ due diligence. In short, I was looking to make sure that the deal looked as financially solid as my clients had been led to believe, and thereafter, I was trying to confirm whether my client would be able to collect from the guarantors if the borrower did not pay and there was a shortcoming in what was recovered from the property.
Finally, I turned my review to the specifics of the borrower. In this instance, there were actually a few borrowers, each being LLCs that were to own an indivisible interest in the subject property. As they would each be signing the deal documents, I needed to make sure that I knew who would be signing for each LLC. In this portion of my due diligence, I needed to review the operating agreements for each LLC to see who would sign for the entity, as well as to confirm that the signor actually had the authority of the LLC to sign such documents. I ran into a few complications in this portion of my review as each LLC had been set up as a single-asset LLC, with the operating agreement of each stating that the ‘purpose’ of the LLC was to own and manage that single asset, which asset had long since been sold or transferred. Had my client moved forward with having the LLC managers sign the deal documents, and had the deal gone south, it is likely that my client would have had some difficulty in securing its interests as the LLCs’ members would have claimed that they never entered into the contracts, and they would have been correct in saying so. Legally, it would have been as if the managers were rogue, not acting as the operating agreements allowed.
We were able to resolve this issue by making sure that we knew how the LLCs’ respective operating agreements could be amended, and then asking each LLC to obtain an amendment to their operating agreement, signed by all required members, that allowed each LLC to engage in the deal, even though the deal fell outside of the LLC’s original purpose, as stated in the original operating agreement of each.
While the above is not an exhaustive explanation of the due diligence I perform for my clients, I hope this serves as an example to you of the types of items you should be reviewing in your deals so that you can be successful in keeping the money that you’ve worked so hard to accumulate.
If you have a transaction coming up and would like my assistance in documenting it or in completing your due diligence, please reach out so that I can assist. Feel free to reach out to me at (602)457-2191 or via email at email@example.com.
By: Michael J. “Mick” McGirr, Esq.